Download Chapter 12 - Dr. George Fahmy

Chapter 12
Inflation, Unemployment, Deficits, and Debt
Chapter Summary
1.
Any event which increases the cost of supplying aggregate output shifts the
aggregate supply curve to the left, causing increases in the price level and
decreases in output. Inflationary pressures stemming from costs (cost-push
inflation) are most often associated with increases in the costs of labor and raw
materials.
2.
Demand-pull inflation occurs when output is unable to meet increases in
aggregate spending. Inflationary pressures can develop prior to full-employment
output when increases occur in aggregate demand and the aggregate supply
curve is positively sloped. Inflationary pressures from increasing aggregate
demand are greater when the unemployment rate falls below its natural rate.
3.
The Phillips curve shows an inverse relationship between the rate of inflation
and the rate of unemployment. the unemployment rate can be pushed below the
natural rate in the short run by increasing the rate of inflation. The
unemployment rate will not permanently remain below the natural rate over
time, however, because of eventual rightward shifts of the Phillips curve.
4.
A federal deficit exists when government outlays exceed revenues. The U.S.
federal budget has been in deficit almost every year since World War II. The
U.S. structural deficit the deficit that exists when output is at its fullemployment level-rose during the 1980s because federal outlays increased at a
faster rate than did federal revenues.
5.
The public debt is the amount owed by the federal government. The U.S. public
debt increased dramatically during the 1980s as a result of increasing federal
deficits. The nominal public debt per capita increased from $1,799.67 in 1970 to
$15,103.34 in 1993.
Important Terms
Cost-push inflation. Inflation caused by increases in the cost of producing output
rather than by increases in aggregate demand.
Cyclical deficit. The federal deficit that arises when output is below its fullemployment level.
Demand-pull inflation. Inflation that occurs because of increases in aggregate
demand.
Phillips curve. A curve depicting an inverse relationship between the rate of inflation
and the rate of unemployment.
Public debt. The amount owed by the federal government; that is, the sum of
interest-bearing debt obligations issued by the federal government.
Stagflation. A situation in which there is increasing inflation and unemployment
simultaneously.
Structural deficit.
employment level.
The federal deficit that exists when output is at its full-
Outline of Chapter 12:
Inflation, Unemployment, Deficits, and Debt
12.1 Cost-Push Inflation
12.2 Demand-Pull Inflation
12.3 The Phillips Curve
12.4 Government Deficits
12.5 The Public Debt
2.1
COST-PUSH INFLATION
Cost-push inflation results from increases in the price of supplying output, e.g.,
increases in the wages aid to labor, in the price of raw materials, and in the business
sector's profit margin on sales. Increases in the price of supplying output shifts the
aggregate supply curve upward and, given an unchanged aggregate demand curve,
results in an increase in the price level and a decrease in output. Because output falls
as the nee level increases, periods of cost-push inflation are referred to as stagflation.
EXAMPLE 12.1. In Fig. 12-1, equilibrium output is initially yf and the price level is
p0 for aggregate supply and aggregate demand curves AS 1 and AD1. Suppose there
are substantial increases in the puce of oil, which raise the cost of supplying output
and shift the aggregate supply curve upward from AS1 to AS2 to AS3. The price level
increases from P0 to P1 to P2 as output falls from its full-employment level yf to y1 to
y2 .
12.2 DEMAND-PULL INFLATION
Demand-pull inflation exists when there are continuous increases in the price
level due to increases in aggregate demand. With a traditional Keynesian aggregate
supply curve, aggregate supply is horizontal until the full-employment level of output
is reached so that demand-pull inflation occurs only after the economy has reached its
full-employment level of output (Example 12.2). When the aggregate supply curve is
positively sloped, increases in aggregate demand raise output and the price level as
there is movement toward full employment (Example 12.3).
EXAMPLE 12.2. A traditional Keynesian aggregate supply curve AS1 is presented in
Fig. 12-2; output yf represents he full-employment level of output. Output is initially
Y1 and the price level P1 for aggregate demand curve AD1. Increases in aggregate
spending which shift aggregate demand from AD1 to AD2 to AD3 increase equilibrium
output from y1 to y 2 to y f with no change in the price level. Increases in aggregate
demand from AD3 to AD4 to AD5, on the other hand, raise the price level from p1 to p4
to p5, and there is no change in output. Hence, for a Keynesian aggregate supply
curve, continuous increases in the price level as a result of increases in aggregate
demand occur only after the economy has reached its full-employment level of
output.
EXAMPLE 12.3. A positively sloped aggregate supply curve AS1 is presented in Fig.
12-3; Yf represents full-employment output. Output is initially y1 and the price level is
P1 when aggregate demand is AD1. Increases in aggregate demand which shift
aggregate demand from AD1 to AD2 to AD3 raise equilibrium output from y1 to Y2 to
y3 and raise the price level from p1 to P2 to p3, although output has not reached the yf
full-employment level. Additional increases in aggregate demand from AD3 to AD4 to
AD5 continue to increase both output and the price level. Note, however, that output
increases are smaller and price level increases are larger as output approaches fullemployment level Yf and the aggregate supply curve becomes more steeply sloped.
Thus, when there is a positively sloped aggregate supply curve, an economy's
inflation rate accelerates as increases in aggregate demand bring the economy closer
to full-employment output.
12.3
THE PHILLIPS CURVE
The analysis in Section 12.2 indicates that when aggregate supply is positively
sloped, increases in aggregate demand raise both output and the price level. A. W.
Phillips, investigating unemployment and price/wage increases over time, found that
low rates of unemployment in Great Britain were associated with high rates of
price/wage rate increase, while higher levels of unemployment were associated with
lower rates of price/wage rate increase. This inverse relationship between inflation
and unemployment, depicted in Fig. 2-4 by curve P1, was designated the Phillips
curve. The negatively sloped P1 Phillips curve was initially believed by some
economists to represent a trade-off between inflation and unemployment. Economists
have found, however, that attempts to push the unemployment rate below its natural
rate result in upward shifts of a short-run Philips curve (e.g., from p1 to p2 to p3)
giving rise, over the long run, to a vertical Phillips curve P L at the economy's natural
rate of unemployment.
EXAMPLE 12.4. Suppose full-employment output is yf and the unemployment rate
consistent with yf (the natural rate of unemployment) is 6%. Output is yf and the price
level is p0 in Fig. 12-5(a) for aggregate demand curve AD1 and aggregate supply
curve AS1. An increase in government spending, ceteris paribus, shifts aggregate
demand outward from AD1 to AD2; output increases to Y1 and the price level
increases to P1 The yf to y1 increase in output is associated with a decrease in the rate
of unemployment; this lower unemployment rate is depicted in Fig. 12-5(b) by a
higher rate of inflation and therefore a movement up Phillips curve P1 and a fall in the
unemployment rate from 6% (the natural rate) to 4%. The P0 to P1 rise in the price
level eventually results in wage increases which shift aggregate supply curve AS 1 to
AS2. Output returns to full-employment level yf, and the price level increases to P2
The increased price level shifts Phillips curve P 1 to P2, and a 6% unemployment rate
is now associated with a 2% rather than a 0% rate of inflation. Additional attempts to
lower the unemployment rate below 6% cause further shifts of the Phillips curve to P3
and P4, indicating that, over the long run, the Phillips curve is a vertical line at the
natural rate of unemployment.
12.4 GOVERNMENT DEFICITS
A federal deficit exists when government outlays exceed revenues. Fig. 12-6
presents the U.S. federal deficit for the years 1965 to 1993 by relating the deficit to
GDP. Note the increases in the federal deficit that occurred in the 1980s; this has
become an important issue in the 1990s.
A structural deficit is one that exists when output is at its full-employment level,
which in 1989 represented approximately 2.9% of U.S. GDP. While many
economists advocate a reduction in the economy's structural deficit, few would
support legislation which would mandate an annually balanced budget.
An annually balanced budget would be procyclical and would aggravate
economic fluctuations; lower tax revenues during a recession would necessitate
reduced government spending (which could deepen a recession), while government
expenditures would be increased during an expansion because of greater income tax
receipts.
EXAMPLE 12.5. Federal receipts and outlays as a percent of gross domestic
product are presented in Fig. 12-7. Notice that since 1965, federal outlays have
exceeded federal receipts each year except for 1969. Also note that the increasing
relative size of the deficit during the 1980s is the result of relatively larger
government outlays rather than large reductions in tax receipts.
EXAMPLE 12.6. The structural deficit is the deficit that exists when output is at its
full-employment level; a cyclical deficit is the amount of the deficit that is
attributable to output being below its full-employment level. In Fig. 12-8, yf
represents full-employment output. The economy's structural deficit is $200 the
deficit that exists at full-employment level yf [$500 in government spending less
$300 in net tax receipts]. Note that the deficit increases to $300 when output declines
to yf, which is not surprising since there are smaller tax receipts and larger
government transfers at output yf .thus ,at output y1 the $300 deficit consists of a
$100 cyclical deficit.
2.5 THE PUBLIC DEBT
The public debt is the amount of interest-bearing debt issued by the federal
government at a point in time. On December 31, 1993, the U.S. federal debt was
$4,408.6 billion. It is frequently argued that a Large public debt will result in default
and federal bankruptcy. the federal government will not default, however, since it has
the power to print money and the power to tax. Because the market knows that the
government will not default, the federal government can always repay a maturing
debt obligation by issuing a new debt obligation. however because of possible
redistribution effects, there is concern about the Large increases in the U.S. federal
debt. A rapidly rising federal debt necessitates larger and larger interest payments.
Government must therefore increase taxes in order to pay its higher interest expense,
causing a redistribution of income from those who pay taxes to those who have
substantial wealth. There is also a transfer of real output from the domestic economy
to foreign economies to the extent that the federal debt is foreign-owned.
Government
 Assets
Interest-bearing debt
Currency
 Liabilities
–$1000
+$1000
Private Sector
 Assets
Interest-bearing debt
Currency
 Liabilities
–$1000
+$1000
EXAMPLE 12.7. Suppose a government's public debt is $1000. This country could
retire all interest-bearing debt by issuing currency, i.e., by monetizing its debt. In the
T account below, the federal government retires its interest-bearing debt (+$1000) by
issuing currency (+$1000). The private sector now owns currency (+$1000) rather
than interest-bearing debt (-$1000). Monetizing a country's debt in a short period of
time would result in inflation and a loss of the currency's purchasing power Thus, a
country which continuously has a budget deficit is advised to borrow rather than to
monetize the deficit.
Solved Problems
COST-PUSH INFLATION
12.1. (a) What is cost-push inflation?
(b) Identify and explain which of the following economic events will result
in cost-push inflation. (1) An increase in government spending, ceteris
paribus; (2) an increase in corporate profit margins. ceteris paribus; (3)
an increase in exports, ceteris paribus,' (4) an increase in nominal wages.
ceteris paribus; (5) a decrease in the price of raw materials. ceteris
paribus.
(a) Cost-push inflation occurs when increases in the cost of producing goods
and services shift the aggregate supply curve to the left; output falls and
the price level increases.
(b) The economic events in (2), (4), and (5) affect the cost of producing
goods and services and therefore shift aggregate supply. Events (2) and
(4) will result in cost-push inflation; they raise the cost of production,
shifting aggregate supply leftward and increasing the price level. Event
(5) lowers the cost of production and therefore shifts aggregate supply to
the right. lowering rather than raising the price level. The economic
events in (1) and (3) shift the aggregate demand and not the aggregate
supply curve and therefore result in demand-pull inflation.
12.2.
In Fig. 12-9, equilibrium output is initially y 1 and the price level is P1 for
aggregate supply and aggregate demand curves AS1 and AD1.
(a) What happens to both aggregate supply and aggregate demand when
there is a large increase in the price of raw materials, ceteris paribus?
(b) What happens to output and the price level as a result of this event?
(a) The increase in the price of raw materials raises the cost of producing
goods and services. As a result, the aggregate supply curve AS1 shifts
leftward to AS2, and there is movement along an unchanged aggregate
demand curve.
(b) The price level increases from P1 to P2 as output declines from y1 to y 2.
12.3. (a) What is stagflation?
(b) What causes stagflation?
(a) Stagflation occurs when unemployment is increasing because of a
stagnating economy and the price level is rising. Thus, stagflation is
characterized by simultaneous increases in the rates of unemployment
and inflation.
(b) Stagflation is the result of cost-push inflation. Stagflation occurred in the
United States and in other industrialized countries during the 1970s and
early 1980s as a result of cost-push shocks originating from large
increases in the price of oil. In this case, large increases in the cost of a
basic raw material caused leftward shifts of aggregate supply, increases
in the price level, and decreases in output.
DEMAND-PULL INFLATION
12.4. (a) What is demand-pull inflation?
(b) Which of the following events can result in demand-pull inflation? (1)
An increase in investment spending, ceteris paribus; (2) an increase in
corporate profit margins, ceteris paribus; (3) an increase in the income
tax rate, ceteris paribus; (4) an increase in government transfer
payments, ceteris paribus.
(a) Demand-pull inflation is the result of increases in aggregate demand
which are not met by increases in output without a rise in the price level.
Demand-pull inflation normally occurs when output is nearing the fullemployment level.
(b) Events (1), (3), and (4) affect aggregate demand. Events (1) and (4)
increase aggregate spending, shift aggregate demand to the right, and,
with a positively sloped aggregate supply, increase the price level. Event
(3) lowers aggregate spending and shifts aggregate demand to the left.
Event (2) impacts aggregate supply, shifting it to the left.
12.5.
A traditional Keynesian aggregate supply curve AS1 is plotted in Fig. 12-10.
Suppose aggregate demand is AD1 and successive increases in government
spending shift aggregate demand rightward to AD2, AD3, and AD4. Have any
of these increases in aggregate demand resulted in demand-pull inflation?
Each of the rightward shifts of aggregate demand in Fig. 12-10 increases
output and has no effect upon the price level since the aggregate demand
shifts occur over the horizontal portion of the aggregate supply curve. Thus,
none of the increases in government spending result in demand-pull inflation.
12.6. A positively sloped aggregate supply curve AS1 is plotted in Fig. 12-11.
Suppose aggregate demand is AD1 and successive increases in government
spending shift aggregate demand rightward to AD2, AD3. and AD4. Have any
of these increases in aggregate demand in Fig. 12-11 resulted in demand-pull
inflation?
Because aggregate supply is positively sloped. each rightward shift of
aggregate demand increases the price level, thus, in these circumstances each
increase in government spending results in demand-pull inflation.
12.7.
Why might there be upward pressure on the price level prior to the economy's
reaching its full-employment level of output?
In highly industrialized economies, labor, natural, and capital resources
are not homogeneous but rather are highly specialized. And in a country the
size of the United States, some economic resources are also geographically
immobile. Thus, there is not one market for an economic resource such as
labor. but instead there are a large number of separate and distinct markets. It
therefore follows that some specialized resources become fully employed
before others; thus, bottlenecks or spending imbalances develop as output
approaches its full-employment level. Increases in aggregate spending
therefore raise output in some industries and prices in others; industries in
which resources are not fully employed can expand output, whereas other
industries in which resources are fully employed raise prices.
12.8.
(a) Suppose an economy's final output consists of the five goods listed in
Table 12-1, Find the average price of these goods and the nominal value
of final output.
(b) Suppose personal income taxes are lowered to increase spending since
output is below its full-employment level. The output levels after the tax
cut are presented in Table 12-2, Find the average price of these goods
and the nominal value of final output.
(c) Compare output in Tables 12-1 and 12-2 to establish the industries which
were closest to the full-employment level prior to the tax cut.
(a) The nominal value of final output is the sum of the dollar value of the
five goods produced, in this case $645. The average price of output is a
weighted sum of the price of each good and can be found by dividing the
nominal value of final output by the total units of output or by weighting
each unit price by the ratio of each good's output to that of total output.
The average price of output is $1.84.
(b) The nominal value of final output has increased to $766; the average
price of output is $1.99.
(c) The tax cut has affected the demand for each of these five goods.
Industries producing Goods A, B, and D are able to expand output
without increasing prices; industries producing C and E appear to be
closer to full employment prior to the tax cut since the increase in
demand has a larger impact on price than on output.
THE PHILLIPS CURVE
12.9. (a) What is a Phillips curve?
(b) Explain why there should be an inverse relationship between the rate of
unemployment and the rate of inflation as a result of shifts in aggregate
demand along a stable, positively sloped aggregate supply curve.
(a) The Phillips curve depicts an inverse relationship between the rate of
unemployment and the rate of inflation. This inverse relationship is
reasonable since, in the absence of cost-push inflation, increases in the
price level (and therefore inflation) should occur as output nears its fullemployment level (and unemployment approaches the natural rate of
unemployment).
(b) Shifts of an aggregate demand curve along a positively sloped aggregate
supply curve produce a positive relationship between output and the
price level. Increases in aggregate demand bring output closer to full
employment but put upward pressure on the price level. Decreases in
aggregate demand lower output and the price level. Since output is
inversely related to the rate of unemployment, it follows that increases in
aggregate demand along a positively sloped aggregate supply curve
lower the unemployment rate and increase the inflation rate, while
decreases in aggregate demand increase the unemployment rate while
lowering the inflation rate.
12.10. In Fig. 12-12 (a), aggregate demand curve AD1 and aggregate supply curve
AS1 intersect at full-employment output Yf. The natural rate of unemployment
is 6% and the inflation rate is π1 along Phillips curve P1 in Fig. 12-12(b).
(a) Introduce an increase in government spending which shifts aggregate
demand curve AD1 to AD2. What has happened to output and the price
level in Fig. 12-1 2(a) and the unemployment rate and inflation rate in
Fig. 12-l2(b)?
(b) Will the unemployment and inflation rates in Fig. 12-12(b) remain at the
level established in part (a) when aggregate demand remains at AD2?
(a) Output in Fig. 12-12(a) increases to y2 while the price level rises to p2 In
Fig. 12-12(b) there is movement up Phillips curve p1; the unemployment
rate declines to u1 while the inflation rate increases to π2.
(b) Output will not remain at Y2 nor will the unemployment rate stay at u 1.
Because the inflation rate has increased from π1 to π2, labor demands an
increase in its nominal wage, which shifts the aggregate supply curve
AS1 leftward to AS2 in Fig. 12-12(a). Output returns to yf and the price
level increases to p3. Aggregate supply shifts inward as a result of this
increase in the cost of producing output; the Phillips curve in Fig.
12-12(b) shifts rightward to P2; and the unemployment and inflation
rates are now 6% and π2.
12.11. Can the unemployment rate remain below its natural rate in the long run?
An economy's unemployment rate can be below the natural rate in the
short run but not in the long run. Increases in aggregate spending, which keep
output above the economy's full-employment level, are eventually met by
leftward shifts of the aggregate supply curve which move output back toward
its full-employment level. Shifts of aggregate supply occur because an
abnormally low unemployment rate results in labor shortages which increase
wages and the cost of producing output.
GOVERNMENT DEFICITS
12.12. (a) What is a federal deficit?
(b) What is the difference between a structural deficit and a cyclical deficit?
(a) A deficit exists for the federal government when (1) its outlays
(government expenditures plus transfers) exceed its gross tax revenues or
(2) government expenditures exceed net tax receipts (gross tax revenues
less transfers).
(b) There is a structural deficit when government outlays exceed tax receipts
at the full-employment level of output, i.e., when government revenues
at their maximum under the existing tax structure are insufficient to pay
for all government outlays. Net tax receipts decline as output falls, since
gross tax revenues are directly related to income. and transfers (e.g.,
unemployment insurance) increase when there are fewer jobs and more
people are unemployed. A cyclical deficit develops when government
expenditures are unchanged and net tax receipts decrease because of
lower output.
12.13. In Fig. 12-13, T' represents net tax receipts, while G' represents government
expenditures; full-employment output is yf.
(a) Why are net tax receipts positively related to output, whereas
government expenditures are constant?
(b) Find the structural and cyclical deficit when output is yf and y1.
(a) Net tax receipts equal gross tax revenues less government transfers.
Gross tax revenues are positively related to output because must federal
taxes are based on private-sector income. Government transfers are
negatively related to output since transfers, such as unemployment
insurance, increase when fewer people are employed. Government
expenditures are unrelated to income since most congressionally
authorized expenditures are not tied to the receipt of tax revenue.
(b) The structural deficit is unrelated to output; it is BC at output levels y1
and yf. There is no cyclical deficit when output is at full-employment
level yf; it is AB when output is y1 and below full employment.
12.14. How can the structural deficit be reduced?
In the short run, the structural deficit can be reduced by increasing tax
revenues or by decreasing government outlays (transfers or expenditures). A
structural deficit can also be reduced in the long run if tax revenues increase
faster than government outlays. Economic growth results in higher output.
Higher output produces greater tax revenues because many private-sector
taxes are related to income. By restricting the growth of government outlays
as tax revenues increase, the structural deficit decreases as a result of
economic growth.
12.15. (a) Should Congress try to avoid annual federal deficits by passing
legislation that mandates that the budget be balanced annually?
(b) Why is a cyclically balanced budget more advisable than an annually
balanced budget?
(a) The government should not try to balance receipts and outlays annually
since an annually balanced budget will be procyclical-i.e.. recessions
will be deeper and expansions more inflationary. Tax revenues
automatically fall with output. and thus a mandate for an annually
balanced budget would require that government spending be reduced as
revenues fall. Since the expenditure multiplier is larger than the tax
multiplier, an equal decrease in taxes and government expenditures
would cause greater reductions in aggregate spending and deepen a
recession. Similarly, during an expansion increased government
expenditures would further expand aggregate spending and accelerate
inflation.
(b) A cyclically balanced budget is one where there is no federal deficit for a
complete business cycle. A cyclically balanced budget overcomes the
procyclical disadvantages of an annually balanced budget by allowing
for deficits during recessions, surpluses during expansions, and a
balanced budget over the business cycle. While theoretically appealing, a
cyclically balanced budget may be difficult to implement. Since each
business cycle has unique characteristics, each recession and each
expansion is usually not of the same magnitude or duration. Thus, it may
be impossible to equate government receipts and outlays over each
business cycle.
THE PUBLIC DEBT
12.16. (a) Will the federal government default or go bankrupt as a result of an
increasing public debt?
(b) Does a large public debt place a burden on future generations?
(a) Default occurs when a borrower fails to meet its financial obligations.
Bankruptcy exists when a borrower's debts far exceed its ability to meet
its financial obligations. The federal government will neither default nor
face bankruptcy since it has the power to tax and print money. Suppose,
for example the federal government has no tax revenue to meet interest
payments. It can secure whatever funds it needs by raising taxes.
Alternatively, since it is the sole issuer of paper currency, it can print
paper currency and use it to meet interest payments. Thus. government
has virtually unlimited sources of funds to meet the interest payments on
its debt.
(b) A public debt places a burden on future generations to the extent that
taxes are imposed on later generations to pay interest on the debt and to
the extent that the debt is foreign-owned. Interest payments impose a
burden in that government taxes current income to make interest
transfers to those who own the debt. In addition, when government
borrows from foreigners, future generations must be taxed not only to
make interest payments but to eventually repay the debt. which reduces
the quantity of goods available in the domestic economy.
12.17. Suppose the federal debt is $100,000 and is completely owned by the banking
system.
(a) Use T accounts for the Federal Reserve and for the banking system to
record the Federal Reserve's purchase of the existing $100,000 interestbearing debt owned by the banking system.
(b) Why is a country ill-advised to monetize its interest-bearing debt?
(a)
Banking System
 Assets
Government securities
Reserves
 Liabilities
–$100,000
+$100,000
Federal Reserve
 Assets
Government securities
–$100,000
Bank reserves
 Liabilities
+$100,000
(b) The Federal Reserve monetizes debt by purchasing interest-bearing
government securities. The banking system upon selling these debt
instruments to the Federal Reserve has additional reserves which allow
the banking system to increase the checking-deposit component of the
money supply. Governments are ill-advised to monetize debt to
eliminate interest-bearing obligations because doing so might effect too
large an increase in the money supply, resulting in inflation.
Multiple Choice Questions
1.
An increase in the cost of producing output, ceteris paribus,
(a) increases the price level and real output.
(b) increases the price level and decreases real output,
(c) increases the price level and has no effect upon real output,
(d) has no effect upon the price level or real output.
2.
When there is a Keynesian aggregate supply curve, an increase in aggregate
demand results in proportional increases in
(a) real output, as long as output is below its full-employment level,
(b) the price level, as long as output is below its full-employment level,
(c) the cost of producing real output, as long as output is below its fullemployment level,
(d) real output once output is at its full-employment level.
3. An increase in aggregate demand results in an increase in output
(a) and in the price level when there is a Keynesian aggregate supply curve,
(b) and no change in the price level when aggregate supply is vertical,
(c) and in the price level when aggregate supply is positively sloped,
(d) and no change in the price level when aggregate supply is positively
sloped.
4. The Phillips curve shows that
(a) high unemployment rates are associated with low inflation rates,
(b) high unemployment rates are associated with high inflation rates,
(c) high unemployment rates are associated with a large increase in the
nominal wage,
(d) high inflation rates are associated with a small increase in the nominal
wage.
5.
In the short run. increases in the nominal wage are associated with
(a) movement up a Phillips curve,
(b) an outward shift of the Phillips curve,
(c) a decrease in the rate of unemployment,
(d) increased likelihood of demand-pull inflation.
6. The existence of a natural rate of unemployment suggests that
(a) there is no inflation-unemployment trade-off in the long run,
(b) nominal wage increases lag price increases in the long run,
(c) nominal wage increases lead price increases in the long run,
(d) the short-run Phillips curve is steeper than the long-run Phillips curve.
7.
A federal deficit exists when
(a) government expenditures are greater than gross tax revenues plus
government transfers,
(b) government expenditures plus government transfers are greater than gross
tax revenues,
(c) gross tax revenues less government transfers are greater than government
expenditures,
(d) gross tax revenues plus government transfers are greater than government
expenditures.
8.
What happens to the structural deficit and the cyclical deficit when the
unemployment rate is above the natural unemployment rate?
(a) The structural deficit increases; there is no change in the cyclical deficit.
(b) The structural deficit and the cyclical deficit increase.
(c) The cyclical deficit increases; there is no change in the structural deficit.
(d) The cyclical deficit increases, while the structural deficit decreases.
9. The public debt imposes a burden on future generations when
(a) the government balances the budget over the business cycle,
(b) it is completely owed to citizens of the issuing country,
(c) it is largely owed to foreigners,
(d) taxes do not have to be increased in the future to cover higher interest
payments on the debt.
10. The federal deficit increased during the 1980s because
(a) federal outlays increased at a faster rate than federal transfers,
(b) federal outlays increased at a faster rate than net tax receipts,
(c) federal outlays increased at a faster rate than federal revenues,
(d) government expenditures increased at a faster rate than federal transfers.
True or False Questions
11. An increase in personal income tax rates results in cost-push inflation.
12. Output decreases and the price level increases when there is cost-push inflation.
13. Demand-pull inflation will never occur unless output is at its full-employment
level.
14. Demand-pull inflation results in stagflation.
15. The Phillips curve shows that there is an inverse relationship between the
inflation rate and the unemployment rate in the short run.
16. Rightward shifts of the Phillips curve are caused by leftward shifts of aggregate
supply.
17. The unemployment rate will not be below the natural rate of unemployment in
the long run.
18. The United States has had a cyclical deficit every year for the past 40 years.
19. The structural deficit decreases over time when federal outlays increase at a
slower rate than federal revenues.
20. The Federal Reserve is monetizing the public debt when it implements openmarket operations and purchases government securities from the private sector.
Answers to Multiple Choice and True or False Questions
1.
(b)
6.
(a)
11.
(F)
16.
(T)
2.
(a)
7.
(b)
12.
(T)
17.
(T)
3.
(c)
8.
(c)
13.
(F)
18.
(F)
4.
(a)
9.
(c)
14.
(F)
19.
(T)
5.
(b)
10.
(c)
15.
(T)
20.
(T)